Flanigan’s (BDL): A Cheap, Complicated Restaurant Chain Focused on South Florida
Flanigan’s (BDL) is a nano-cap full service restaurant and discount liquor store company. All of its locations are in Florida. And all but one of the locations are in South Florida. The company’s ticker – “BDL” – comes from the name of its liquor stores: Big Daddy’s Liquor. Meanwhile, the company’s name – Flanigan’s – comes from the name of its founding and still controlling family. One family member is directly involved in the business – as the Chairman and CEO for the last 18 years – and his brothers who serve on the board and also own entities connected to the company. There is a family trust as well. Altogether, insiders of some sort own about 50% of the company. Although I referred to this company as being both a full service restaurant chain and a chain of discount liquor stores – the discount liquor stores mean very little in an appraisal of the company. About 90% of the company’s EBIT comes from the restaurants. So, less than 10% of earning power comes from the liquor stores. Also, the returns on capital in the restaurant business are much higher than in the liquor stores. If you don’t adjust for leases – which changes the calculation of ROC with the new accounting rules adopted in the last few years – the restaurant chain’s returns on capital are probably around 25% pre-tax (so, high teens after-tax) while the liquor stores are more like 7% or so pre-tax and maybe 5% or worse after-tax and in cash. Restaurants are often valued on EBITDA or EBITDAR (EBITDA before rent) instead of EBIT. So, if anything, I’ve used a somewhat more conservative measure. Most importantly, though, is that the company says it doesn’t intend to open more liquor stores. It is going to use some space that had been planned for a restaurant expansion to instead do an additional liquor store. But, overall, the company doesn’t intend to put more capital into the liquor store business. Since the liquor store business is less than 10% of earning power here already and the company intends to re-invest free cash flow in additional restaurants, but not additional liquor stores – there’s really no point in an analyst wasting their time worrying about the value of the liquor stores, their competitive position, etc. I will just mention two synergies here. The liquor stores are often co-located with the restaurants. Not always. But, often enough to make it worth mentioning. And then the other synergy would be liquor sales at the restaurant. Flanigan’s restaurants get about 75% of revenue from food sales and about 25% from bar sales. Gross margins at the restaurants are very high (compared to other restaurants) at around 65%. The fact the company is buying so much alcohol so frequently from the same distributors in the same region of the same state suggests that ownership of the liquor stores may help increase buying power, lower costs, and thereby achieve higher margins at the bar. It’s also worth mentioning the difference between revenue and gross profit. I said that 25% of revenue was from the bar. But, note that if gross margins at a bar are meaningfully higher than on food – this would result in a much greater share of gross profit (relative to revenue) coming from the bar. For example, the company could be getting 25% of revenue from its bars, but more like a third or four-tenths (40%) of gross profits from bar. Imagine they do get 40% of gross profits at each restaurant from the bar. The restaurants as a whole are nine-tenths of earning power. So, as much as like 35% of the company’s reported earnings could really be coming from the bars. Regardless of how you look at it, the bars taken as a whole are more important profit contributors than the actual liquor stores. So, I think the bars are worth thinking about as a business and the restaurants (excluding bar sales) are also worth thinking about. But, I don’t think the liquor stores are worth worrying about. As a result, I’ll be talking about the restaurants and bars at those restaurants – but, not about the liquor stores.
Flanigan’s is a casual concept with restaurants located in South Florida. The restaurants are nautical themed – they have pictures of boats and fish and stuff like that – and focus on selling a good amount of alcohol. Some of the restaurants don’t close till 1 a.m. to 5 a.m. depending on local laws. This, along with the company’s liquor store business, suggests a strong focus on drinking. In fact, Flanigan’s started out as an operator of cocktail lounges that did not serve much in the way of food. Over time, though, it repositioned itself. The company traces its roots to 1958. It is still headquartered and incorporated in Florida. It once operated locations outside Florida – but, no longer does. It also managed – it didn’t own – a strip club in Atlanta. It is no longer involved in that business. Laws were changed causing the club to be closed down. It wasn’t a major contributor to earnings recently anyway. A somewhat meaningful contributor is a restaurant called “The Whale’s Rib” which Flanigan’s runs but does not own. That restaurant probably brings in about $750,000 a year of which around $375,000 goes to Flanigan’s and $375,000 to the restaurant’s owners. All other locations – so, really everything I’ll be talking about in this article – are “Flanigan’s” branded restaurant locations only. They’re standardized. It’s a true chain. Purchasing is done at HQ for both food and liquor. The company has a fixed supply agreement, invested in half ownership of a fish importing company, etc. to secure low cost supplies. I already mentioned the liquor supply. There doesn’t seem to be an unusual amount of autonomy at the restaurant level here. The company uses supervisors over the GM level who focus on a small number of restaurants. Considering these restaurants are all fairly closely clustered in South Florida – the degree of oversight from the supervisors is probably high. It wouldn’t take much work to be visiting individual restaurant locations frequently. So, this is not a company like Ark Restaurants (ARKR). It’s a chain. I know it’s unusual to look at chain restaurants with market caps this low. But, that’s happening here for two reasons. One, the stock is cheap. Normally, a restaurant stock would be about 3 times more expensive than this one. So, a market cap of like $30 million here should really be more like $90 million. Secondly, this chain is very regionally focused on South Florida. So, it’s not known around the country. And, finally, systemwide numbers here are actually like double the numbers we see for EBITDA, because the way the company has structured its franchises, limited partnerships, and incentive program for executives means that insiders and investors in each of the various restaurant projects end up keeping about 50% of the cash earning power with the other 50% going to shareholders of Flanigan’s. If you factor in those two things, the actual chain of restaurants like this one would have a market cap closer to $200 million than $30 million. It’s $30 million in this case because EBITDA for the public company is only like 50% of EBITDA for the whole chain and then the stock trades below 3 times prior peak EBITDA.
The accounting here is complicated. And this would definitely be the first worry of most investors looking at this stock. Related party transactions are extensive. In fact, most investors have probably never analyzed a company with as many related party transactions as this one. However, the related party transactions here – and the bonuses, which I’ll get to in a second – are extraordinarily simple affairs. Whether or not you as a shareholder like the arrangements – you can easily understand them.
Flanigan’s used to franchise locations and still has franchised locations. The franchisees are members of the Flanigan family (among others). However, this is not real relevant to our discussion here, because Flanigan’s hasn’t franchised a location in like 35 years and says it doesn’t intend to franchise more locations. As a side note, the fact that these locations are still producing positive cash flow 35 years later is pretty impressive. A lot of individual restaurants locations don’t survive 35 years. The Flanigan chain is made up of some pretty old restaurant locations. A lot of them were opened under the current CEO. About 9 of the locations (the majority of the chain) were founded between 8 and 23 years ago. Of those, 8 were founded between 12 and 23 years ago. About half of those were founded in the 13-15 year range and the other half in the 19-23 year range. These are old, continuously profitable locations.
One reason we know about the profitability and age of specific locations is the way they are set up. As I said, Flanigan’s hasn’t franchised locations for 35 years. So, how do you create a chain without franchising? The company does not have much net debt – it does, however have a lot of gross debt offset by a lot of cash on hand. So, the start-up costs of the restaurants and any initial losses would have to be shouldered by the company itself. Most chains of restaurants are: 1) Franchised or 2) Have better access to capital (debt raises, stock issuance, etc.) or 3) Spread quickly through leasing locations at malls across the country. Flanigan’s leases some locations but actually owns some others. I’m not going to delve deeply into the stuff they own – but, it’s actually significant compared to most restaurant chains. They own a collection of like 9 small buildings throughout South Florida – often acquired a while ago – which includes their headquarters as well as liquor stores and restaurants. The cap-ex here also looks very high in many years for a restaurant chain. So, compared to publicly traded restaurant companies – Flanigan’s has plowed a lot more of their free cash flow into capital investment whether through ownership of land or through improving the building they are leasing. Where do they get the funds?
Insiders and family members mostly. When Flanigan’s wants to open a new restaurant it sets up a limited partnership. The company takes an LP stake – (always between 5% and 49%, most commonly between 25% and 45%) and takes the entire GP stake. The LPs are structured along a “return of capital” approach. So, entities other than Flanigan’s – it looks like a lot of insiders, family members, and other affiliates – put in between 55% and 75% or so of the cost of the new restaurant. They then get paid back over a period of about 4 years (if the restaurant is immediately successful). They only get paid back 25% of what they put in per year provided there are distributable cash flows from the restaurant. So, this would mean a payback period no shorter than 4 years. In theory, the payback period could be anyt number of years (beyond four)– but, Flanigan’s doesn’t have any restaurant that hasn’t fully paid back its LPs. Once the LPs are repaid – and remember, Flanigan’s the company is also an LP to some extent in each of these restaurants – the GP starts getting paid. The general partner collects 50% of distributable cash flow from the restaurant and the LPs collect the other 50%. This would suggest that if Flanigan’s owns between 25% and 45% of the LP interests and 100% of the GP interests they’d be getting like 63% to 73% of the “free cash flow” from the restaurant. Let’s not be that precise – say, 60% to 75% on average.
Now, in reality, it’s quite a bit less. That’s because of the bonus scheme here. A further 20% of the restaurant’s cash flow will end up going to the top 3 executives at Flanigan’s, because the bonus scheme is basically 20% split about 15%, 2.5%, 2.5% between the CEO, the COO, and the CFO. As a result, you can think of Flanigan shares as being part of a structure where you – kind of like an LP in a hedge fund – get 80% of profits but management takes 20% of profits. There is a threshold amount and some other complicating factors. But, there is also – normally, not in this COVID year – meaningful (but not remotely excessive) base salary payments to management as well.
As a result, I think the best way to think of this is a system where – on average – Flanigan shareholders get somewhere between 60% and 75% of restaurant free cash flow less 20% paid to management equals 48% to 60% of free cash flow.
There’s also those franchises and more normal SG&A expenses etc. But, it’s unlikely to be much less (or much more) than about one-half of the actual free cash flow of the restaurants.
In exchange for this, you have a company that isn’t using a lot of net debt, doesn’t have a lot of SG&A that’s inflexible, etc. – but, can still expand.
Is it a good trade-off?
I think most investors will say no. It’s a lot of related party transactions. It’s a controlled company. The auditor – Marcum – has been censured by the PCAOB In the past and has been this company’s auditor for 21 years. Marcum is, however, a pretty normal choice for an auditor for a company like this. It’s not a small auditor. It’s not cheap.
Disclosures here also seem to me to be very, very good versus what a company could get away with. For example, I’m pretty sure they are disclosing legal issues that other restaurant companies have and just don’t disclose. The explanations, disclosures, etc. of the LP structures and who is a partner of each and how much they receive from the LPs and so on is good. I also liked the disclosures on properties, insurance, and subsidiaries of the company. In general, I found the level of disclosure of many things to be much higher than I’m accustomed to even with much, much bigger public companies. I don’t know the COO, CFO etc. here. I don’t know if everyone involved in the LPs is honest and careful not to take advantage of public shareholders of Flanigan’s. But, I can see that the finance and legal people at this company aren’t amateurs and do understand this company and the structures it is using well.
Also, and this is more subjective, I’m not as bothered by the related party transactions as other investors are likely to be because of the incentives. I went through the filings comparing things like the amount of compensation coming from the bonuses, the payouts from the LPs, the value of the common stock people at the company hold, etc. – and I can come to only one conclusion. The incentives are strongly skewed for insiders to worry about maximizing EBITDA at BDL. If they want to get rich, they should definitely do that. It’s easy to see why this is. Insiders already own plenty of BDL. Increasing EBITDA will – over time – increase the value of the shares they own. It pays a small dividend. This is funded through EBITDA and will rise along with it over time. But, most importantly, they – and by, “they” I especially mean the Chairman and CEO – also have a large bonus paid out based directly on EBITDA at BDL. If you think about it, the stock price of BDL moves with EBITDA and the bonus moves with EBITDA. So, if you are getting a bonus equal to 15% of EBITDA and own 20% of the company, your incentives (when you have a small base salary and small distributions received as a result of being an LP) are strongly directed at growing EBITDA at the BDL level.
Also, BDL isn’t really on the other side of the table from insiders invested in other restaurants all that often. How the LP is financed and how quickly LPs are paid back and stuff like that is where I see possible conflicts. These get into issues of advancing money to the LPs and stuff like that. There are also obviously tax differences between what a corporation and what an individual LP might like to see and stuff like that. But, overall – BDL is usually a major LP as well as the GP, and the GP and LP both are getting all payments based on the same metric: distributable cash flow. To me, it looks like BDL and insiders at BDL whether as management looking for bonuses, shareholders looking for stock price appreciation, or LPs looking for payouts – all are aiming at increasing EBITDA.
However, ownership of LP interests and being paid in a large bonus does skew some incentives for management. But, not in a way I mind. You’ll notice that management would be more incentivized to worry about the stock price if they had to sell stock to fund their lifestyle, etc. They don’t. They get some small distributions as LPs (based on EBITDA) and they get big bonuses based on EBITDA of the company. This leaves the question of how much management cares about the EV/EBITDA multiple of the stock. Honestly, they own stock and should care a bit. But, it’s probably a bit less than at your more typical public company.
I haven’t talked much about the underlying business fundamentals here. Lately – before COIVID – they had been good. Comparable sales at both the restaurants and the bars were strong year after year. This is probably due to price increases on both menus and also to unusually heavy cap-ex at existing restaurants compared to what a lot of chains do. Returns on capital are good. Comparable store sales excellent. And the expansion of this concept has been slow and focused on a small part of the country. It’s all the stuff you usually want to see with a restaurant company.
It’s also an undeniably cheap stock. Market cap is only like 3 times actual “cash flow from operations”. It’s maybe 7 times free cash flow. But, that FCF actually includes a bit of expansion cap-ex and heavier cap-ex in general than I think most restaurant stocks would be doing. The quality of earnings here seems really high in the sense that if we are pricing off actual CFFO minus cap-ex these last three years – that FCF number is a really solid and conservative one.
It’s also possible this stock is kind of cheap versus book value. That’s not something I’d usually think of with a restaurant stock. But, book value here is unusually “hard”. You can look at the note on depreciation yourself to see how much of book value is in land, building, etc. You can see for yourself that the stock has a market price of around $17 a share and book value is more like $24 a share. I don’t know how significant this is. One day, the company might choose to unwind some of its liquor operations. If it ever chooses to do that, it might have some book value associated with that which can be liquidated and re-invested in restaurants or something. More likely, it will keep piling up a little bit of real estate along with a lot of leased properties throughout South Florida.
Finally, I didn’t discuss leases. There are some risks here. In theory, something like 20% of the company’s restaurants come off lease in the next 6 years or so. By this I mean there is neither a unilateral option to purchase the location or a unilateral option to extend the lease. For most restaurant companies, this isn’t an issue. It can be an issue if you are focused on extremely high traffic and desirable locations. It has – for example – been a real problem for Ark over the years. But, it’s almost never a problem for most restaurant stocks.
Rent here is a significant expense. EBIT has been $6 million to $7 million recently while rent has been $4 million. About $3.2 million of that is fixed regardless of sales while $800,000 is tied to sales performance.
Finally, there is an added risk here: hurricanes. The company warns that it might not be able to obtain adequate insurance at reasonable prices. All bars can have trouble with liability insurance due to “dram shop” laws which mean you could be responsible for harm done to others by drunks you illegally served. There are special caps and higher deductibles and things on some of this insurance – it’s all disclosed in the 10-K and none of that worries me. However, discussion of the coverage for windstorm (that is, hurricane) damage does concern me more. Remember, basically 100% of this company’s locations are in South Florida. It’s easy for a restaurant to be damaged such that it can’t be open for a time. And having locations shut for a time can mean a permanent hit to loyalty and difficulty re-opening. The company pays over $500,000 a year in premiums for this kind of coverage. I don’t know if that’s sufficient. And I’m not sure I’d be able to evaluate this even if there was more disclosure about the amount of coverage the company has. If you look at the company’s balance sheet and then also look at its locations – this is potential a pretty big insurance risk for someone to take on. An insurer could have to pay out a large amount from a single hurricane that hits South Florida.
It’s something to keep in mind both in the sense of a risk I can’t quantify and also as a possible buying opportunity to evaluate if a major hurricane does a ton of damage to the company’s properties and they have a big loss beyond what they are uninsured for.
From a balance sheet perspective, I think they could handle it. I don’t think hurricane losses over insured limits is likely to bankrupt this company. But, it might hurt the stock a lot if people assume there is adequate insurance and there isn’t.
Overall, I think this is one of the cheapest and most interesting restaurant stocks I’ve come across.
Geoff’s Initial Interest: 80%
Geoff’s Re-visit Price: $11.50/share